Review Difference between fixed and variable resources Define and give an example of the law of diminishing marginal returns Identify the three stages of returns Where is the long-run equilibrium price in perfect competition Identify the difference between the short-run and the long-run Define productive efficiency and the price Define allocative efficiency and the price List 10 names that start with “J”

Long-Run Costs

Definition and Purpose of the LONG RUN In the long run all resources are variable. Plant capacity/size can change. Why is this important? The Long-Run is used for planning. Firms use to identify which plant size results in the lowest per unit cost.

Definition and Purpose of the LONG RUN Ex: Assume a firm is producing 100 bikes with fixed amount of resources (workers, machines, etc.).  If this firm decides to DOUBLE the number of resources, what will happen to the number of bikes it can produce? There are only 3 possible outcomes: 1. # of bikes will double  Constant Returns to Scale 2. # of bikes will more than double Economies of Scale 3. # of bikes will less than double Diseconomies of Scale

ECONOMIES OF SCALE Why does economies of scale occur? Firms that produce more can better use Mass Production Techniques & Specialization. Example: A car company that makes 50 cars will have a very high average cost per car. A car company that can produce 100,000 cars will have a low average cost per car. Using mass production techniques, like robots ($500,000), will cause total cost to be higher but the average cost for each car would be significantly lower. 5

Long Run ATC What happens to the average total costs of a product when a firm increases its plant capacity? Example of various plant sizes: I make stools out of my garage with one saw I rent out building, buy 5 saws, hire 3 workers I rent a factory, buy 20 saws and hire 40 workers I build my own plant and use robots to build stools . I create plants in every major city in the U.S. Long Run ATC curve is made up of all the different short run ATC curves of various plant sizes. 6

Long Run AVERAGE Total Cost Costs MC1 ATC1 $9,900,000 $50,000 $6,000 $3,000 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 7

Long Run AVERAGE Total Cost Costs MC1 ATC1 $9,900,000 $50,000 $6,000 $3,000 ATC2 MC2 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 8

Long Run AVERAGE Total Cost Economies of Scale- Long-Run Average Total Cost falls because mass production techniques are used. Costs MC1 ATC1 $9,900,000 $50,000 $6,000 $3,000 MC2 MC3 ATC3 ATC2 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 9

Long Run AVERAGE Total Cost Constant Returns to Scale- The Long-Run Average Total Cost is as low as it can get. Costs MC1 ATC1 $9,900,000 $50,000 $6,000 $3,000 MC2 MC3 MC4 ATC2 ATC3 ATC4 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 10

Long Run AVERAGE Total Cost Diseconomies of Scale- The LRATC is increasing as the firm gets too big and difficult to manage. Costs MC1 ATC1 $9,900,000 $50,000 $6,000 $3,000 MC2 MC5 MC3 MC4 ATC5 ATC2 ATC3 ATC4 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 11

Long Run AVERAGE Total Cost These are all Short-Run ATC curves. Where is the Long-Run Average Total Cost curve? Costs MC1 ATC1 $9,900,000 $50,000 $6,000 $3,000 MC2 MC5 MC3 MC4 ATC5 ATC2 ATC3 ATC4 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 12

Long Run AVERAGE Total Cost Long Run Average Cost Curve Costs $9,900,000 $50,000 $6,000 $3,000 Long Run Average Cost Curve 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 13

Constant Returns to Scale LRATC Simplified The law of diminishing marginal returns does NOT apply in the long-run because there are NO FIXED RESOURCES. Costs Economies of Scale Constant Returns to Scale Diseconomies of Scale Long Run Average Cost Curve Quantity 14